Quick & Easy Guide to Financial Terms

If you are new to the world of loans and financing and have been looking for a quick and easy guide to understand the various terms and short forms commonly used in the Banking and Financial Services Sector, then continue reading further. A loan is a financial arrangement where one individual, entity or organization lends money to another individual, entity or organization who needs the funds. The borrower is granted a sum of money called principal at a cost called interest, which must be paid back at a later date agreed by upon by both parties, who are bound by a contract called a loan agreement. Loan financing is often needed by individuals, entities and organizations for financing their personal and/or business needs. There are various types of loans available in the market ranging from Two-wheeler Loans, Used Car Loans, SME Loans/ Business Loans to mortgages like Loan Against Property, and more.

Some of the most commonly used terms in the world of personal or corporate finance have been explained below:

1. EMI- Equated Monthly Instalment

NBFCs/ Financial Institutions offer loans for a fixed amount and time period, the borrower needs to pay to the lender a Equated Monthly Installment called EMI, which consists of interest and principal so that in future the entire loan amount and interest is repaid by a certain date.

1. Down Payment

NBFCs/ Financial intuitions usually finance a percentage of the amount and the remaining (usually about 10-30%) has to be paid at the time of availing the loan by the borrower. This payment is called a down payment. Banks do this to reduce risk and minimise the chances of default.

1. Pre-EMI

Some home loans are disbursed partially until the property is under construction. During this period, the borrower must only pay the interest on the amount disbursed instead of the principal amount. This interest payment is called Pre-EMI. In case the property construction takes more time to finish, the borrower ends up paying more interest amount.

1. Post Dated Cheque

Post dated cheques are cheques issued by the borrower to the bank for a period of 1-2 years, which have a later clearing date. These cheques are used by the NBFCs/ Financial Institutions to withdraw EMI's from the borrowers account through ECS.

1. Electronic Clearance System

An Electronic Clearance System (ECS) is an easy way to transfer funds electronically from one bank to another. Individuals and organizations use this facility to transfer payments, taxes, salaries, etc. to others to minimize hassle and save time.

1. Sanction Letter

The confirmation letter stating that a borrower is eligible for a loan is called a sanction letter. It is important to note that this letter is only an acknowledgement of the borrower's ability to avail a home loan and not an actual loan agreement.

1. Disbursement

Loan disbursement is of three types: advance, full, and partial. If the lender releases a partial loan amount before completion of construction of property, it is called an advance disbursement. Partial disbursement means the borrower has to only pay the interest on the principal amount until completion of construction. In a full loan disbursement, the lender releases the full loan amount and the borrower starts repaying the principal and interest amount from the next month itself.

1. Loan-to-Value or LTV Ratio

LTV ratio is a term used by lenders to describe the ratio of the loan amount to the value of the asset purchased. Most loans types fall in the band of 60-80% LTV ratio.

1. Type of Rate of Interest

The Rate of interest is fixed or floating. Interest on principal amount is calculated in two ways called simple interest (interest on principal amount) and compound interest (interest on the principal amount and interest earned).

1. Security or Collateral

A security or a collateral is an asset owned by the borrower that they can pledge for a loan. In the event of non-payment, the lender can use the collateral to reclaim their outstanding amount.

1. Default

The inability of a borrower to repay his/her EMI as per schedule is called default.

1. Credit Score

A credit score is a number assigned to individuals, entities, and organizations depending on their financial habits. This number is calculated based on your financial history and your predicted ability to repay a borrowed amount.

1. Tenure

The duration for which loan is disbursed is known as tenure of the loan. It can be specified in days, weeks, months or years.

1. Co-Signer

A co-signer is a person who signs the loan with a pledge to repay the loan in case the original borrower defaults on loan repayment. This is an easy way for people of low income to avail of loans in times of need.

1. Escrow

An escrow is a financial arrangement where a third party holds and regulates the payment of funds required for a transaction between the first two parties.

1. Net Income

Net income is a company's total profit/ individual's income after subtracting all other costs, taxes and expenses.

1. Processing

The time and effort required from the time of receiving a loan application to disbursing the loan constitutes loan processing.

1. Re-financing

Re-financing is replacing an existing loan with a new loan with a different payment schedule. The new loan repays the old loan that may not be working in the borrower's favour. Refinancing often helps reduce costs and ease the repayment burden on the borrower.

1. Asset

In commonly used Financial Intuition's parlance, an asset is a belonging of value that the borrower can pledge as a collateral.

1. Business Credit Profile

A business credit profile is a collection of information based on a business's credit profile, credit history and credit score that can help a bank gauge their ability to repay a loan.

1. Cash Flow

The total amount of money from a business that is used to manage day-to-day expenses of the said business is called a cash flow. Excessive cash flows in the business can impact the business negatively because there is no way the business can save money to expand.

1. Fixed Asset

A tangible asset that can be seen, touched and monetized is called a fixed asset. Fixed assets are usually used as collaterals to avail of a loan. Fixed assets carry a high value and serve as long- term investments.

1. Gross Profit

In accounting terms, gross profit simply means the amount left when total inventory is subtracted from total revenue. Gross profit doesn't include deductions arising from tax payments.

1. Interest-Only Payments

As the name suggests, these are payments made on the interest arising on the principal amount. The principal amount is either refinanced or paid in lump sum at a later date.

1. Liability

Liabilities are the debts owned by a business which can be paid off in the form of payments arising from sale and transfer of goods and services. Liabilities must be paid off by the earliest as they potentially reduce a company's gross profit.

1. Line of Credit or Credit Line

A credit line is a revolving amount of funds that can be accessed over and above the borrowed amount based on the borrower's needs. The extra credit must be repaid back based on the total amount borrowed and interest due.

1. Principal

The principal is the base amount that is being borrowed. It does not include interest component or processing fees.

1. Revenue

Revenue is the total income/ turnover generated by a business. It does not factor costs, expenses or taxes.

1. Secured Loan

A secured loan is a type of loan where the borrower must pledge a collateral i.e. something of financial value that the lender can take over and sell off should the borrower default on the loan repayment.

1. Unsecured Loan

An unsecured loan is a type of loan where the borrower is not required to pledge a collateral. Typically, consumer loans are unsecured loans since the goods procured with loan money acts as a lien.

1. Term Loan

A term loan is a type of loan where a lump sum amount is released to the borrower who has to repay it in EMI, over a fixed tenor or duration of time.

Whether you are a student, professional, or a small business owner wanting to take a first- time loan, learning what makes each loan different and the terms that are commonly used will help you understand which financial solution is best suited to your financing requirements.